Placing S corporation stock into a revocable living trust saves the beneficiaries of your estate probate costs after your death. The trust can continue to hold S corporation stock for up to two years. Once the trustee pays funeral expenses, settles any outstanding debts and files the final tax returns for the estate, your heirs will receive their designated shares of stock. After two years, S corporation stock loses its S status and becomes a C corporation.
Setting up a living trust involves transferring ownership of your assets to the trust. You can transfer S corporation stock to your living trust while you are alive. If you do not want your heirs to receive the stock directly following your death, the stock can be transferred to another trust that qualifies for S status. By putting some or all of your assets into a living trust, you retain the right to manage them throughout your lifetime as long as you appoint yourself as trustee. You will continue to report income earned by assets held in the trust on your personal income tax return.
An S corporation differs from a C corporation in that the corporation’s earnings and losses are passed on to the owners. Unlike a C corporation, which must pay both federal and state income taxes, an S corporation does not have to pay corporate income taxes. The earnings are taxed only at the shareholder level. This saves the owners tax dollars. Any losses are deducted from ordinary income. Income from a C corporation is taxed twice -- at the corporate level and again at the shareholder level when the earnings are distributed. Losses are deducted from corporate earnings alone.
Special rules apply to living trusts if the owner transfers stock or shares in a corporation to the trust. Only certain kinds of trusts qualify to be shareholders of an S corporation. These rules apply because federal tax laws do not require a qualifying S corporation to pay taxes on the income it earns. A qualified subchapter S trust allows only one beneficiary, or one person to receive income from the trust. A grantor trust is also eligible to hold S corporation stock. All income or losses generated by the trust are passed to the grantor, who is considered as the owner for federal income tax purposes. Finally, an electing small-business trust can have more than one beneficiary and still hold S corporation stock.
Other Factors to Consider
Although a living trust will avoid probate proceedings, the assets are still subject to estate taxes. However, structuring a living trust in proper fashion may save your heirs money in tax dollars. Beneficiaries and heirs also have the legal right to challenge the validity of a living trust just as they would a will. Another factor to consider when setting up a living trust is that stock placed in an S corporation can remain in the trust for no more than two years following the owner’s death. After that time, if the stock is not distributed to the heirs, beneficiaries or other eligible trusts, it could lose its S corporation status and become a C corporation. Conversely, an estate can hold the stock until probate is complete and the estate is settled. There are no time restrictions.
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